Written by Ng E-Jay
14 Feb 2009
Acting Manpower Minister Gan Kim Yong announced in Parliament on Friday that the CPF Life scheme would be simplified to give CPF members four options rather than an original 12. The scheme, which rolls out in 2013, gives monthly payouts for life from age 65 onwards based on the amount the member has in the retirement account. The four options given allow the member to choose whether to receive a higher monthly payout and leave less for the beneficiaries, or receive a lower monthly payout and leave more for the beneficiaries.
This is an appropriate juncture to give a summary of my main views on the CPF Life scheme.
In my view, the CPF Life scheme is highly deficient in that:
- the payouts are not indexed to inflation,
- the Government has not expressed any desire to co-fund the scheme, and
- the payout amount is subject to drastic change in the event that interest rates fall or life expectancies improve significantly.
The compulsory nature of the CPF Life scheme, or more generally, the compulsory nature of the Minimum Sum scheme itself transfers both control and responsibility of a person for his assets to the Government. This places a great moral responsibility on the Government to manage those assets in a transparent and accountable manner, and deliver returns that are on par with or even better than the best that the private sector can provide.
In particular, if both the Minimum Sum and CPF Life schemes are to be compulsory, the onus must be on the Government to play its part in ensuring that payouts remain relatively stable no matter how interest rates or mortality rates may change. This has not been done, and this deficiency form the crux of my critique of the scheme as it is currently presented.
On self-reliance, sustainability, Government co-funding, and greater transparency
The Government’s view is that the CPF system is fully funded because it should be based on the cardinal principles of self-reliance and self-provision, and these principles must be maintained for the CPF Life scheme which should avoid the pitfalls of under-funded national pension schemes in other developed countries.
While the above reasoning appears logical on the surface, there are deep flaws which really speak of the cold, calculating attitude of the Government towards the people.
During a citizen’s productive years, he or she works hard and contributes to our economic growth. The entrepreneurial drive and industry of Singaporeans is what makes our nation wealthy. The taxes paid by citizens are used by the Government to build infrastructure, develop new technologies, keep our streets and borders safe, and create a conducive environment that attracts investments and creates jobs.
When people grow old and retire, it must be the responsibility of the Government to take care of them using the wealth built up by the nation, as it was these people who made that wealth possible in the first place. This is a basic tenet of democratic socialism.
To suggest that people rely solely on each others’ pocketbooks and never on the Government’s surpluses for their retirement needs is mean spirited and heartless, and reduces each person to an economic digit. A country that is being run as a mere corporation loses its soul and its identity, and becomes a hotel rather than a home, a mere stepping stone for those who are able to come and go.
Rather than leaving Singaporeans to fend for each other alone, the Government should co-fund the scheme by injecting surplus funds from the budget and directing more of the Net Investment Income (NII) into the scheme in order to enhance payouts. The NII is the investment income of our reserves, which are in turn derived from the blood, sweat and toil of generations past. The Government should use this rich source of funds to help Singaporeans retire with dignity.
The Government is correct to say that the scheme must be financially sound and sustainable over the long run. But in the present situation without Government co-funding, the CPF Board reserves the right to drastically reduce members’ payouts should interest rates fall or life expectancy increases unexpectedly. This will certainly affect members’ quality of life and may cause hardship. Hence, Government co-funding is necessary to protect members from fluctuations in interest rates and life expectancy which are outside their control, and enable them to retire with peace of mind.
Lack of adequate inflation protection
Over the years, despite sporadic bouts of high inflation, interest rates have remained persistently low, and have recently fallen even further in the wake of the current financial turmoil. CPF members and retirees have had their purchasing power reduced as CPF interest rates and Minimum Sum payouts have not kept pace with inflation over the past decade.
The CPF Life scheme does not index its payouts to inflation, putting participants at risk of not having sufficient income to meet their basic living expenses in their later years. For example, assuming that the inflation rate is a steady 3% per annum, a monthly payout of $600 begun at age 65 will only have the purchasing power equivalent to $385.12 at age 80, and $332.21 at age 85 — not very much different from the original amount promised by the Government under the now-defunct Longevity Insurance proposal with strictly non-refundable premiums!
In the brochure “A Quick Guide to CPF Life” published by the Ministry of Manpower (MOM) in 2008, it was explained that the scheme offers some limited protection against inflation as payouts are pegged to prevailing interest rates, which are supposed to rise with inflation.
However, experience in the very same year showed that this need not be the case. For example, the three-month Singapore interbank offered rate (Sibor) dropped to a record low of 1.76 per cent in Feb 2008, its lowest level since Feb 2005, despite escalating inflation during that time. The Sibor stayed persistently low in 2008 through periods of high inflation and subsequent disinflation when the credit crunch hit.
Given the apparent disconnect between prevailing interest rates and the rate of inflation, I am concerned that CPF Life payouts will not be adequate for retirees’ needs should inflation take root and trend higher in the decades ahead, as is expected to be the case given all the money printing going on in the world right now. It is imperative that a greater degree of inflation protection be afforded to CPF members.
Lack of universal coverage of the scheme and lack of a strong social safety net for the underprivileged
An estimated 25% of active CPF members who turn 55 in 2013, the first cohort who will participate in the CPF Life scheme, will have less than $40,000 cash balance in their Minimum Sum and will be excluded from the scheme although they can opt in. And even if the Government provides financial incentives to encourage these groups of people to opt into the scheme, they will still be left without a strong safety net, given that their monthly payouts will likely be extremely small.
A longer term approach has to be devised to help the poor, especially those without the minimum of $40,000 cash balance in their Minimum Sum.
Some back-of-the-envelope calculations
I have made some back-of-the-envelope CPF Life calculations. This example is for a male participant who has $67,000 cash in his CPF Minimum Sum (assuming a total Minimum Sum of $134,000, of which half is property pledge, and half is cash savings).
These are my assumptions:
- The Government makes a consistent rate of return of 5% on ALL of its funds under management. That is, the Government is able to invest both the Retirement Account (RA) and Refundable Premium (RP) at an ROI of 5%. Any amount left in the RA is distributed to beneficiaries upon demise, but the RP fund is not. The RP fund is the “common pool” used to provide perpetual income for surviving members.
- The investment return on the RP fund is NOT accrued to the CPF member’s account but instead held in Government coffers. ONLY the investment return on the RA is accrued to the CPF member’s account and distributed to beneficiaries in the event of early demise.
- Monthly income of $610 begins at age 65.
- The member chooses the default plan.
- When the member is between the ages of 65 and 80, I am assuming his contribution to the RP fund is not used to provide monthly payments — only the RA funds inclusive of interested earned are drawn down to provide the monthly payments.
- I am also assuming that after the age of 80, the Government starts paying off the member using the pooled RP fund including any residual amount left in the RA, while continuing to invest the pooled fund at an ROI of 5%. However from this point onwards, none of the interest earned is accrued to the member’s CPF account as the RA portion has become nonexistent.
The following table shows the balance amount in the member’s RA and RP account at each age from 55 to 95, the amount that the beneficiaries would get in the event of demise, as well as the net profit that the Government earns from the scheme, which is the interest earned from the RP pool minus the cumulative payouts made to the CPF member.
The member gets $7,320 per year, based on a monthly income of $610. As can be seen from the table, the RA fund has insufficient balance to pay the member by age 80, and subsequent payouts are made from the pooled account.
By the age of 80, the Government is estimated to have as much as $38,373 net profit. That is a HUGE profit for the Government! In fact, the net profit for the Government increases to a high of $45,723 by the time the member reaches age 83! Clearly if the CPF member passes away around the ages of 80-85, the Government stands to earn a LOT OF MONEY from the scheme! This is because the interest earned on RP fund is NOT given to the beneficiary but kept in the common pool upon the member’s death.
As can also be seen from the table, the amount of money that left outstanding in the member’s account rapidly diminishes after 80, so that by age 84, the beneficiary would get NOTHING in the event of demise of the member. However, the Government coffers still have a lot of cash. There is enough cash in the Government coffers to pay the member $610 per month for several more years while still maintaining profitability from the scheme. It is only AFTER the age of 90 that the Government starts losing money on the scheme.
This back-of-the-envelope calculation shows that even assuming the Government is right about half of CPF Life participants surviving to 85 years of age, the Government will clearly make a net profit from most members, given that comparatively fewer members will make it past 90 years of age.
It is therefore very fair to assume that the Government could perpetually generate large surpluses from the scheme, especially when we take into account the fact that premiums and monthly payouts will be altered in accordance with morality experience and the return of investments, thereby ensuring that the Government seldom goes into deficit in any particular year.
The CPF Life scheme is an attempt to repair a national pension system that has become inadequate in sustaining members through old age. The reason why the CPF system has become deficient in the first place is because of persistently low interest rates paid on CPF accounts, which has prevented members from building their wealth, as well as members having to pay a large amount of funds towards their property. As a result of these two factors, and to some extent the inadequacies of the Medisave system in taking care of members’ medical needs, the CPF Life scheme is needed to fill the gaps of this sinking ship.
My back-of-the-envelope calculation coupled with the Government’s current stand that premiums and monthly payouts will be altered in accordance with morality experience and the return of investments shows that even when implementing the CPF Life scheme, the Government is mercenery enough to insist that it has virtually a 100% chance of making a good profit from the scheme.
My take therefore is not that people should be made to adhere to the principles of self-reliance and self-provision at all cost, but that the Government should be weened of its reliance on the people to fatten its already bulging coffers, and instead help provide for the peoples’ retirement from its massive vaults which house the blood and toil of generations past.